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Wednesday, June 19, 2013

Making Sense of the High Return Investment Options

The promise of high returns on investment can seduce even the most conservative of all investors. Why settle for the safe 6-10% presented by a bank fixed deposit when you can earn near double from other investment options? This prospect is attracting small investors to innovative investments, ranging from the rather safe corporate fixed deposits to the complicated forex trading, even exotic opportunities like art.
Most of these investments were in the past being recommended only to the super-rich, who could afford high risk involved. Nowadays, however, they are being aggressively sold even to small investors.
Adverts on prominent websites tempt inexperienced investors to start trading in forex and earn big cash within no time. Bank executives push you into trying their highly flourishing portfolio management scheme (PMS). Brokers press you to consider experimenting in commodities futures, sharing sure winning tips that can make you rich. You are promised double-digit return on investments. In some instances, the returns are even 'guaranteed'.

Prospecting investors have been repeatedly warned that high returns come with high risk. I’m not going try to challenge this belief, because it is always true. Therefore, I would like to examine some of these investment options to explain the risks they involve and the expected returns. Here are some of these Investments:

Fluctuations in foreign exchange rate are good news to daring investors who can gain from the volatility by trading in the forex. However, don't fall victim of forex trading portals, which promote their services with promises of huge returns within no time.
The risks: Like speculation in stocks, forex market trading is more of a “zero sum game’’. (The quotes should remind you that investment should never be confused with gambling). One trader's gain is another trader's loss. Therefore, before you venture into foreign exchange trading I would advise you to learn the basics first. Even when you think you understand forex trading, you need to be extra careful. The positions are leveraged and, so, the risk is inflated 10-12 times. You may also consider buying forex derivatives, like put and call options, on the New York Stock Exchange, which limit the risk to the premium paid.
Still, these are complicated financial instruments, so be sure on what you are putting your money on before placing your order. The forex market is impacted by a number of factors, many of which cannot be easily tracked by the retail investor. Enter only if you are aware of the dynamics of the currency
The Beauty: The only tempting bit of forex trading is its prospective high return on investment. Do it right (plus a bit of luck) and you can double your investment in no time. The trade is also flexible as you can go for either long-term approach or short-term once depending on your risk tolerance and confidence level.
2) Foreign stocks
Just like you buy stocks of companies in your country, you can also invest in foreign equities. Nevertheless, very few investors try this option. There are numerous brokers providing an online platform to get access to global equities.  For example, a Kenyan investor can easily purchase stocks listed on the NYSE.
The risks: Equities are intrinsically risky investments, but foreign stocks are way riskier than domestic equity. The biggest danger in investing abroad is the ever fluctuating foreign exchange rate. If your investment country’s currency depreciates against that of your country, your returns will be eaten into. You will receive a lesser amount upon conversion of the foreign currency back to your domestic currency. Again, if your domestic currency strengthens, for instance against the dollar, your investments in the US stocks would suffer.
The beauty: If your country’s economy was to sputter at 5%, the domestic stock market won’t be able to generate very high returns. However, your global market investments will be cushioned against the decline in the domestic market. This advantage of diversification is multi-branched because you are investing in another country, with a different currency.
Some investors prefer buying a large number of low-priced shares over a small number of high-priced shares. They trade in penny stocks (a stock with a value of $5 or less per share) in the hope of making it big one day. Since these stocks cost less, one can buy a large number of shares.
The motivation is that the low-priced stocks can easily offer huge returns because of their low base. If, for instance, a $ 5 share rises by even$ 1, the investor pockets a cool 20% return.
The risks: Penny stocks may be lowly priced but the mistake of investing in them may be too big to bear. There is high risk of losing your entire capital. Most penny stock issuers are small, obscure firms about which little or no information available. No analyst will spend his/her time researching these stocks. Very low liquidity and capitalisation also make them easy targets of price manipulation. Unscrupulous agents keep pumping up the price even as operators entice unsuspecting investors to these stocks. Their lack of trading volumes also makes it impossible for one to exit to exit when he/she really wants to.
The Beauty: If luck is on your side, you may find a penny stock that turns into a giant stock.
4) Corporate Fixed Deposits
If you are not satisfied by the 6-10 percent interest offered by the banks on fixed deposits, you can go for corporate fixed deposits (FDs) that give 2-3 percentage points higher rates for comparable tenures. However, unlike bank fixed deposits, which are insured and guaranteed, corporate fixed deposits offer no guarantee. Your sole lifebuoy is the credit rating given to the deposit, which point out the degree of safety or the confidence in the issuing company.
The risks: Corporate fixed deposits offer higher interest rates because they are riskier compared to bank fixed deposits. These deposits are unsecured and there is very little an investor can do if the issuer is incapable of returning his money. The return of the principal and timely payment of interest depends fully on the financial health of the issuing company.
The Beauty: A few, well researched corporate fixed deposits will provide that extra juice to your portfolio. The higher return is good for those who want to get rich first but be careful not to jeopardise your entire principal for the sake of higher rates.
Not many years ago, only the ultra-rich were offered portfolio management services (PMS). Nowadays, however, even upcoming investors are being lured to these products. The PMS providers invest in a mix of stocks, derivatives, debt, and commodities. Every investor is allocated a professional fund manager to handle his investments. A fee is charged in return. It's more like a mutual fund only that the investor has a say in the investment portfolio. The PMS scheme can be tailor-made to suite the investor’s needs. A PMS can either be discretionary, where the manager takes decisions on behalf of the investor or non-discretionary, where the manager only gives suggestions.
The risks: Though PMS schemes have the same risk as the stocks in which they invest, their risk is compounded by giving a free hand to the fund manager.  The fund manager can easily use investor’s cash to play around with the market leading to massive losses. Another risk is that, unlike a mutual fund investment, there is no regulation of the fee charged by a PMS. Low liquidity, high entry barrier and high tax rates are some characteristics of Portfolio management schemes which turn investors away.
The Beauty:  If you are an investor looking for level of customisation then PMS is definitely the right investment option. Simply put, PMS are convenient.
6) Alternative investments
There isn’t any distinctive definition of alternative investments.  Therefore, any investment that is not conventional can fall in this group. These can include structured deals (gold-linked bonds, Nifty-linked bonds) or passion investing (stamps, wine, coins, and art). However, this is an option that only the superrich investors can take. The entry size is high and you require at least five different investments to make certain some level of portfolio diversification.
Also, Alternative investments will require very long holding periods to produce returns, particularly if you are buying artefacts or art. It takes more than one generation to realize any noteworthy appreciation in art value.

The risks: The low liquidity of alternative investments makes them very risky. While some investments like stamps, wine and coins can be done with relatively small capital, others like paintings and structured deals may run into hundreds of a thousand or even millions of dollars. With high entry size, diversification difficult, escalating the risk further.
The Beauty: If you are superrich and don’t mind the wait you can consider Alternative investment Fund (AIF). When he has landed a huge deal, an AIF investor can split his deal among willing investors hence reducing the ticket size and increase his diversification prospects. By allowing investors to move together, AIF gives them a better bargaining power.

7) Stock Futures and Options (F&O)
Equity investments are known to yield high returns for patient investors. For those of us who are impatient, there are some equally good equity derivatives. You can make up to five times the stock profit by investing your cash in the futures and options (F&O) market. In Future contract, the investor agrees to sell or buy shares at a given price on a future date. Options Contracts are slightly different, since the buyer has the right (but not obliged) to buy or sell the given stock at a particular price on a particular date. This high-risk market enables the investor to place highly leveraged bets on specific shares and indices. You are required to deposit a mere 15-20% of the transaction value as margin.
The risks: While the futures market increases your potential returns by about five times, the risk is similarly high. You can easily lose more than your invested amount. Options have a lower risk because your loss is restricted at the premium you have paid. Equity investments are risky because you are putting your bet (and safety your cash for that matter) on the future growth of the issuing company. And given the extra leverage of F&O, you are surely treading on dangerous ground.
The Beauty: The opportunities in F&O are genuine and can reward the impatient investor, but it can also quickly unravel.

8) Commodities
Buying and selling commodities has long been the realm of savvy and active investors. Nowadays, however, it has attracted even the interests of lay investors. Here, you bet on the future price movement of whichever commodity, including precious metals (silver, gold), industrial metals (copper, aluminium, nickel), or agricultural products (mustard oil, soya, chana, etc), and energy commodities (natural gas & crude oil). You just need to have a separate demat account for dealing in these items.
The risks: Just like stock futures market, commodities futures also amplify your investment gains and losses. In fact, commodity trading has higher leverage at 10-20 times. Such a high leverage can be very risky for the young investor, who is not very much conversant with the market dynamics
The beauty: Commodity trading is not for everyone. Try it only if you have a great understanding of commodities and can digest the daily volatility. If you feel you have the knowledge and the guts then you can try it out. You never know you may be the next billionaire.
Developers in Real estate often sell project units even before construction is initiated. Buyers are lured by projected returns of up to 50 percent. Rarely do they advertise these offers and so they travel via word of mouth among connected individuals. Once money starts flowing in from the real estate consumers and prices go up, the trader can sell the property for a cool profit. However, don't take the developer’s word for it because the anticipated returns depend on the future increase in property prices.
The risks: The riskiest part of a pre-launch offer is that the builder may not have obtained all the approvals. He may also be planning to sort out some legal issues beforehand. Another risk is that the developer may not be financially stable. Therefore, he may be selling a project at a discount to the get money to start him off. This is not a good sign. The other risk is delay in construction which can lead to huge losses on the side of the investor.
The Beauty: Though not meant for end users, Pre-launch investments can work well for investors with surplus cash and will give good returns.
10) Guaranteed Rental Returns
Developers are also enticing buyers with offers of guaranteed returns from their home investments. The deal is quite simple: the developer takes care of the maintenance of the property and rents it out to corporate clients. The investor receives post-dated cheques based on the expected rental returns from the builder. A maintenance contract can vary from 2 to 10 years. During this stage, the developer retains the possession of the property.


The risks: A builder may lag on his promise. Rental income depends on the type of apartment, facilities offered and the location of a project. These three vary a great deal, so it is not accurate to guarantee a specific rental yield at the marketing stage. There is also a possibility of the developer declining to renew his contract after some period. So you should be prepared to take over the management and maintenance of the property. 

3 comments:

  1. The investment gives a common man to earn some extra money beside their salary. But it's really important that we choose investment options wisely to get maximum profit with minimum risk. The options listed in the post are good and well described with their respective risks.

    ReplyDelete
  2. Jennifer, it's great we are on agreement on this.

    ReplyDelete
  3. I would like to suggest that you use the #1 Forex broker.

    ReplyDelete